Carbon Tax Phase 2

Video Transcription (from YouTube)

Yesterday, on the 12th of November 2024, South Africa’s National Treasury announced Phase 2 of the Carbon Tax Act. By way of context, Phase 1 of the carbon tax was implemented in June 2019 and will span until the end of 2025, a period of 6.5 years. Phase 2 will run from the beginning of 2026 until 2030, spanning a 5-year period.

What’s important to note is that this 5-year period coincides with South Africa’s third Nationally Determined Contribution (NDC), which I’ll explain shortly. The first NDC goal that South Africa set spanned from 2015 until 2020, the second from 2020 until 2025, and the third, or NDC 3, will span from 2025 until 2030—the same as Phase 2 of South Africa’s carbon tax.

The concept of a Nationally Determined Contribution comes from South Africa’s commitment to the Paris Agreement, an internationally binding treaty from 2015. This agreement established that nations around the world would contribute fairly to reducing global greenhouse gas emissions by each determining their own emission reduction targets, called NDCs. The key principle was that each NDC, whether for the first, second, or third period, must be progressively stricter and more ambitious.

South Africa’s alignment of Phase 2 of the Carbon Tax Act with NDC 3 is no coincidence. It sends a strong signal to the market that South Africa has internationally binding obligations that the country is obliged to meet. Phase 2 of the carbon tax will be stricter than Phase 1, and it signals that the carbon tax is here to stay.

What’s also important to note is that South Africa’s greenhouse gas emissions target has been set at 350 to 420 million tons of CO2 equivalent per year. At present, South Africa is emitting about 450 million tons per year, which means we are significantly over our goal. In order to reach this goal, change is necessary, and carbon tax is the main driver of that change.

A number of our clients have asked us whether the carbon tax will be here to stay or whether South Africa can endure it. What we’ve seen through reading South Africa’s Low Emissions Development Strategy and technical documents from the United Nations Framework Convention on Climate Change (UNFCCC), is that carbon tax is here to stay. It is the primary driver through which South Africa hopes to bring its national greenhouse gas emissions downward.

Why is it Important for South Africa to Reduce Greenhouse Gas Emissions?

There are seven key reasons why South Africa needs a carbon tax:

1. South Africa’s Global Position: South Africa is one of the 20 largest greenhouse gas-emitting nations in the world and the largest emitter in Africa. We trade a lot with other nations, and in fact, in Phase 2 of the Carbon Tax Act, it was noted that the national average trade intensity for goods traded internationally is well above 50%. This means we cannot afford to fall out of favor with countries with whom we trade. Being one of the world’s largest emitters, we have a responsibility to be seen by our trading partners as taking concrete steps to reduce emissions if we want to continue trading with them.

2. The Effect of Climate Change on South Africa: Climate change predictions for South Africa include up to a 4°C increase in inland temperatures, 3°C at the coast, a 20% decrease in rainfall on the west coast, increased rainfall on the east coast, and large areas of the country becoming malaria-prone. These effects are already anticipated, regardless of how much we mitigate. However, we must still play our role as part of the global effort to reduce greenhouse gas emissions and manage climate change.

3. Attracting Investment in Manufacturing: Foreign companies like Volkswagen, BMW, Mercedes, Bridgestone, and Continental choose to manufacture in South Africa, but these companies evaluate their global carbon footprint, and South Africa’s emissions are a significant blot on it. If we do not take meaningful steps toward decarbonization, these companies may be deterred from investing further or starting new operations in South Africa.

4. Building a Green Economy: South Africa’s climate change response is built on three pillars: mitigation (reducing emissions), adaptation (becoming climate-resilient), and financial flows (attracting investments for green projects). A carbon tax is necessary to drive the financial flows that will allow us to finance carbon-resilience projects and become an attractive destination for green investments.

5. Protecting South African Businesses: Climate change will have an adverse impact on business operations, as seen in the April 2022 floods in KwaZulu-Natal, which forced the closure of the Toyota factory. Adverse weather conditions can disrupt business operations, supply chains, and labor. By implementing carbon tax and preparing businesses for these challenges, we can help them adapt and build resilience.

6. Carbon Border Adjustments: The EU and UK have implemented or are considering carbon border adjustment mechanisms (CBAM) for goods such as fertilizer, cement, steel, aluminum, and electricity. If South Africa does not have a carbon tax in place that is aligned with global standards, our exported goods will face additional taxes at the borders. However, if South Africa has a higher carbon tax rate, it can recover more tax revenue, which will benefit the country’s fiscal position.

7. A Just Energy Transition: According to Dr. Dion George, the new Minister of the Department of Finance, we need a just energy transition in which no one is left behind. This means transitioning to a green economy without harming job creation or domestic economic growth. The International Monetary Fund has estimated that even if carbon tax were raised to R120 per ton (compared to the current rate of about R8 per ton), the impact on South Africa’s growth would be negligible—between 0.04% and 0.12%—while the environmental benefits would be significant.

Phase 2 Carbon Tax Details

The Phase 1 carbon tax, implemented in 2019, set a carbon tax rate of R120 per ton of CO2 equivalent but included several tax-free allowances, including a 60% basic tax-free allowance, a 10% trade exposure allowance, and various other allowances such as carbon offset allowances and voluntary carbon budget allowances. These allowances meant that taxpayers were effectively paying only 10%–15% of the actual carbon tax.

However, Phase 2 is expected to phase out these allowances gradually (or more rapidly, depending on the documents reviewed). The tax rates will increase from R120 per ton in 2019 to R462 per ton by 2030, signaling that carbon tax is here to stay and will increase in value.

The discussion paper released on Phase 2 suggests a moderate approach to removing allowances:

1. Basic Tax-Free Allowance: The basic allowance will decrease from 60% in 2026 to 40% by 2030. For businesses that have been receiving 80% allowances, this will mean a doubling in their carbon tax liability by 2030.

2. Performance Allowance: This allowance will increase, but it will only apply to the 16 industries currently eligible.

3. Carbon Offset Allowance: This will increase by 15%, allowing companies to purchase more carbon credits to offset their carbon tax liability.

4. Voluntary Carbon Budget: This will be phased out starting in 2026 and replaced with mandatory carbon budgets. Companies will be assigned a carbon budget by the government, and exceeding that budget will result in a higher tax rate (R640 per ton compared to the standard R462).

5. Trade Exposure Allowance: Companies will need to prove they are more than 50% trade-exposed to qualify for this allowance. Companies with lower trade exposure (between 20% and 50%) will still qualify but with a smaller allowance.

6. Electricity Pricing Neutrality: A shift from the electricity generation levy to carbon tax will take place, ensuring that electricity producers are compelled to reduce their carbon footprint.

7. Section 12L for Energy Efficiency: This will end at the end of 2025, but similar initiatives will be included under the carbon offsets.

Conclusion

Carbon tax is here to stay, and it will become an increasingly important tool for driving South Africa’s emissions reductions. It’s a complex space to navigate, but we are here to help. If you would like us to undertake a carbon tax eligibility assessment, calculate your carbon tax liabilities, or help you with a greenhouse gas mitigation plan, please get in touch with us.